Steve Evans: What would you say to those questioning the sustainability of insurance-linked securities (ILS) instruments and how will you respond if 2014 proves less benign than previous years
Tony Rettino: There are 2 questions here: the first being can they, the second will they? Most of our investors are large institutions committing less than 2% of their assets to reinsurance. If they were to lose 40% of the capital that they committed, it’s a bad month; whereas, if a reinsurer loses 40% of its capital, the reinsurer is likely to lose its rating. The institutional investors that form our capital base can therefore afford to be more concentrated because they are in a much better position to both sustain large losses and to have the financial resources to recapitalize after that loss.
The more interesting and complex question is: will they recapitalize? This is what I see as the central point in the sustainable market question. While clearly some investors in today’s market environment are more temporary, owing to low interest rates and low credit spreads, we anticipate that most large institutional investors will return to the market. The reason being that they spend an enormous amount of time (up to 2 years) performing the appropriate due diligence before investing and have a history of re-investing in this and other asset classes.
An interesting point about our model, relative to a traditional reinsurance model, is that we speak with each of our
investors at least semi-annually and provide extensive details as to the risks of the portfolio. We are a lot closer to our investors and have a strong intuition as to their sustainability following a loss and manage expectations ahead of one.
The next question is, of course, what could change in the above? To have a stable market, the market has to collectively ask itself “just because you can, should you?”. The question for us managers is whether or not we should take on more capital just because we can. For example, should I take that extra $200-300 million that may be put to work in more marginal types of investments? As a privately held firm, we are cautious and look to match capital with opportunities to deploy it; and last year, we actually turned away certain capital. Any new capital has tended to be from new market entrants who are starting with a very small proportion of what they ultimately plan to invest in the long-term.
For both investment managers and reinsurers, one question that needs to be asked is whether we are providing the proper level of transparency to our capital providers. When you think about sustainability, a surprise small loss is worse than an expected big loss. If we, or the reinsurers running sidecars, have not been fully transparent with our investors collectively, then capital may not return and credibility may be questioned.
Some of the sidecars cover business that reinsurers don’t typically write or keep, which, from our perspective, could create some difficulties following a loss event. We have also seen some disruption in the cat bond market over time as a result of structural issues, including the more aggressive collateral structures in the years leading up to the financial crisis.
For brokers and insurers, the question is: just because I can reduce disclosure or push terms and conditions through in order to expand coverage and include unmodeled or poorly modeled perils, is this the right way to build long-term relationships?